Statistics and Government Decision Making
I have been reading news papers on among other things about what they write about economic affairs for the last 50 years or so. They come up with the same conclusions in different languages every x number of years. The same conclusions, of course valid ones, on the quality, reliability, timeliness and comprehensiveness official statistics have now come up again for the nth time. Statistically good performance by newspapers: only they are yet to learn the habit of referring back to the dates when they had published the same conclusions. That would be too much of statistical work to expect of journalist!
Founded by Professor P.C. Mahalanobis in Kolkata on 17th December, 1931, the Indian Statistical Institute gained the status of an Institution of National Importance by an act of the Indian Parliament in 1959. The Government of India had a Central Statistical Organization, a Planning Commission. So many statisticians are employed by the Central and State governments. Like IAS there is a IS (Statistical) S. What the people in ISS have been doing for all these years? Producing unreliable, inadequate and out-of date statistical information for decades (rather more than half a century)? In any case, even if data were collected with diligence, processed accurately and reliable information generated without much time-lag, how that is going to help? If the inflation is high, or food scarcity is acute or the fiscal deficit is high or electricity and coal pilferage is high, Government will still continue to say that they are taking all the various measurers to solve these problems. Quality Statistics is useful in the hands of or to the brains of Quality Decision makers. Poor quality decision-making brains cannot be compensated by improved quality statistics. How much of even the quality statistics currently available helping the Nation? What more information do we need to know more accurately and timely about the percentage of females in the age-group 18 -80 and the conditions of women in order to select women candidates to represent political parties in elections or reserve constituencies for women? How much time we require to decide on these: 60 years or14 years? How much more information did we need to know that which farmers have the lowest productivity in wheat/ rice production per labor or per acre or per kg of fertilizer? What information more is required to decide about what is the optimal pricing of fertilizers?
Statistical information is the staple food for analysts and researchers. They need more information and quality information to search out underlying trends, patterns and probable truths. Statistical information is also required to impress others about the great knowledge that one has: speakers in conferences, political gatherings, elected representative bodies and public debates and TV panels need to give out statistics (relevant or irrelevant, true or contrived, partial or misleading) to make an intellectual impression on the audience and other speakers).
But Statistics has also other probably no less important uses. One of this is for decision-making., rather informed decision –making. When decision-makers require they get out the best possible statistical evidence and take calculated risks to arrive at decisions. Decision-makers know what statistics they need and also know that they cannot get all the statistics they need because statistics data collection has a cost. They therefore follow the rule of working with the minimum but critical statistical information. Good decision makers and policy makers do not complain about statistics not being available: they ensure that the minimum critical and reliable information gets collected. But such good decision makers capable of and actually relying on quantitative statistics are rare. The Government decision-making being a time consuming process involving political, inter-departmental/ ministerial bargaining and clash of ego-based/ ideology-based opinions/ beliefs, seldom does availability of reliable, up-to-date and comprehensive statistics seem to matter much. Only when people trust statisticians on the reliability of statistics they supply, both raw and analyzed, and the decision-makers shed their hunches, beliefs and hidden interest in the decision-outcome, there is a meaning of spending money in collecting and processing statistics. Democratic processes do not make a very congenial atmosphere for effective use of statistical information and methods as decision-making inputs: rather they make a mockery of the use of statistics. Citizens tend to disbelieve the statistics supplied to support official decisions. My observations are simply untested hypothesis: they can be tested by statistics and statistical methods. But such attempts would never be made possible in democracies even if it was possible to effectively enforce the right to information, unless, however, there is a separate and independent government decision evaluation commission that continuously review each government decision on a continuing basis and sends its report directly to the office of the President for record.
Sunday, March 14, 2010
Sectoral Shadow Growth Boxing
Manufacturing jealous of Services?
In recent decades, services sector has grown fast and faster than industry and agriculture. More than half of the GDP or National Income is accounted for by the services sector. When people came to know about this surprising achievement of the services sector for the first time in the early 1990s, they could not believe that half of the GDP had become false (they felt that services sector did not produce something concrete and valuable). The people attached to or employed in industry, especially the engineers had the most resistance to accept the reality of the dominance of the services sector. As an economist or finance person, whenever I talked in seminar or in-house training with engineers as participants, they would point out that this statistics is a serious ailment of the Indian economy and has to be corrected. I had told them that here is no way you can do this. They would give me a smile to acknowledge my foolish belief in the services sector. And, the people born and/ or brought up under Neheruvian Socialist State planning thought that this was due to liberalization and globalization and corruption. They thought this was unacceptable. But we now know the writing on the wall at that time in the past..
Recently, some intelligent young Indians were trying to find out what is important for the future of India: Manufacturing or Services Sector? They, true their inheritance from their forefathers and old teachers, continues to believe that India needs to do great so that Industry again beats services in growth.
There is a general belief that something physical is better than something tangible. Manufacturing is good because you can see them: so TV is good, computer is good, so are cards, soaps, houses, food products, clothing, air-conditioners, mobiles and the like. . The truth is that if the production and consumption of these grow, there is no way one can stop the growth of traders and retailers, construction workers, government employees, bank workers, transportation workers, newsreaders, TV serial actors and actresses, film editors, musicians, cine-technicians and the like benefiting from increased economic activity. Unfortunately, these categories of workers are all producing services in the services sector and not in manufacturing.
We need more schools for our children and hospitals for our people: we invest in schools and hospitals. This investment is in service sector. School and university teachers are providers of service: they are not manufacturing real goods people like to see to feel good. When we invest in schools, hospitals and roads and also get more policemen and government employees to serve the citizens and fight the terrorists, these service sector people not only increase the contribution of the service sector to the national economic growth, they create demand for need various industrial products like cement, paper, books, ink, pen, computers, cars, arms, office equipment and thereby creating growth for manufacturing as also increase demand for more services.
If we know all this, why do we have shadow boxing over whether industry or sector should or can grow faster than the other and waste our energy in artificial controversies created by the economists, politicians and economists? Such shadow boxing does not manufacture anything useful. Nor, does it lead to enhanced quality service to the Nation.
There are countries in the World that have no agriculture and yet rich. Many small countries without much industry have grown because of services sector growth. As household incomes rise they need more of services than they need manufactured or agricultural products. Our country is unable to produce as much food as the people need. Let agriculture grow at least at half the rate at which services sector is growing. We can think of agriculture beating services later. Industry in growing at a few percentage points lower rate than the services sector. Let industry increase its growth rate from its current level. That will however only further increase the growth rate of the services sector. Sector growth rates are inter-linked: no sector can grow faster than what other sectors allow. Instead of thinking about who is better for us, manufacturing or services, let us make agriculture grow faster. With agriculture in such poor shape neither industry nor services will grow fast for long. Sectors do not fight for growth: they help each other to grow.
In recent decades, services sector has grown fast and faster than industry and agriculture. More than half of the GDP or National Income is accounted for by the services sector. When people came to know about this surprising achievement of the services sector for the first time in the early 1990s, they could not believe that half of the GDP had become false (they felt that services sector did not produce something concrete and valuable). The people attached to or employed in industry, especially the engineers had the most resistance to accept the reality of the dominance of the services sector. As an economist or finance person, whenever I talked in seminar or in-house training with engineers as participants, they would point out that this statistics is a serious ailment of the Indian economy and has to be corrected. I had told them that here is no way you can do this. They would give me a smile to acknowledge my foolish belief in the services sector. And, the people born and/ or brought up under Neheruvian Socialist State planning thought that this was due to liberalization and globalization and corruption. They thought this was unacceptable. But we now know the writing on the wall at that time in the past..
Recently, some intelligent young Indians were trying to find out what is important for the future of India: Manufacturing or Services Sector? They, true their inheritance from their forefathers and old teachers, continues to believe that India needs to do great so that Industry again beats services in growth.
There is a general belief that something physical is better than something tangible. Manufacturing is good because you can see them: so TV is good, computer is good, so are cards, soaps, houses, food products, clothing, air-conditioners, mobiles and the like. . The truth is that if the production and consumption of these grow, there is no way one can stop the growth of traders and retailers, construction workers, government employees, bank workers, transportation workers, newsreaders, TV serial actors and actresses, film editors, musicians, cine-technicians and the like benefiting from increased economic activity. Unfortunately, these categories of workers are all producing services in the services sector and not in manufacturing.
We need more schools for our children and hospitals for our people: we invest in schools and hospitals. This investment is in service sector. School and university teachers are providers of service: they are not manufacturing real goods people like to see to feel good. When we invest in schools, hospitals and roads and also get more policemen and government employees to serve the citizens and fight the terrorists, these service sector people not only increase the contribution of the service sector to the national economic growth, they create demand for need various industrial products like cement, paper, books, ink, pen, computers, cars, arms, office equipment and thereby creating growth for manufacturing as also increase demand for more services.
If we know all this, why do we have shadow boxing over whether industry or sector should or can grow faster than the other and waste our energy in artificial controversies created by the economists, politicians and economists? Such shadow boxing does not manufacture anything useful. Nor, does it lead to enhanced quality service to the Nation.
There are countries in the World that have no agriculture and yet rich. Many small countries without much industry have grown because of services sector growth. As household incomes rise they need more of services than they need manufactured or agricultural products. Our country is unable to produce as much food as the people need. Let agriculture grow at least at half the rate at which services sector is growing. We can think of agriculture beating services later. Industry in growing at a few percentage points lower rate than the services sector. Let industry increase its growth rate from its current level. That will however only further increase the growth rate of the services sector. Sector growth rates are inter-linked: no sector can grow faster than what other sectors allow. Instead of thinking about who is better for us, manufacturing or services, let us make agriculture grow faster. With agriculture in such poor shape neither industry nor services will grow fast for long. Sectors do not fight for growth: they help each other to grow.
Saturday, February 27, 2010
Inflation and Price Rise
Economic thinking like habits die hard, rather refuses to die. Inflation in India has been there in India ever since I took my first lessons in Economics nearly 46 years ago in the higher secondary school.
It does not require economists to understand that inflation is bad for most citizens for most of the time (some times for some citizens it may be good, eg., with my salary being linked to inflation during the 1970s, I used to look forward to high inflation because my expenditure pattern was less sensitive to inflation than my income was and less sensitive to inflation compared to many others(maybe I had also sufferred from money illusion) or for example, recently sugar mill companies saw a four fold rise in their profits.
But every citizen is an inflation expert. Almost everyone has the same set of recommendations: government must fix prices of essential commodities and distribute them from fair price shops ( in our childhood days the emphasis was on raiding the traders who were also turned hoarders and on rationing), stop export of essential goods ( India of course have very little of such exports), import from abroad (this prescription is rather a recemt phenomenon after India has moved a little towards globalization: in our childhood days imports were considered as against the great virtue of self-reliance), call strikes and bandhs against the government's inability to curb inflation and so on. Unfortunately, the text books say that to curb inflation in an excess demand situation, one needs to cut demand by reducing disposable incomes in the hands of the people by raising taxes and reducing government expenditure. It is never clear to many students of economics why economics textbooks were so harsh to recommend reducing dispoable incomes by raising income taxes, reducing subsidies and increasing taxes on the production or sales of commodities. Why raise the price of commodities by levying highers taxes when the prices are already going up? Why reduce disposable income of people when they are already unable to make both ends meet. A veteran graduate of Delhi School of Economics and now a prominent communist party leader therefore has said that Finance Minister Pranab Mukherjee's Indian Union Budget announcement to increase the levy on motor spirit and diesel oil will increase inflation especially through the cascading effect. I understand that a rise in tax levies on these fuels will increase prices of commodities and services which consume these fuels for their production and transportation to reach the consumers. But leftist economists generally have difficulty in understanding economic theories developed in the Western countries, except of the Marxian variety. They are not analytically strong enough to differentiate between a one shot price rise (which is not inflation) and a sustained process of rising prices (that is what inflation is). With such economics education it is hardly surprising, no communist country has been able to solve the problem of inflation so far without making goods disappear from the government controlled shops and long queues at their ration shops. It is only more dangerous to India that such politicians claim to be economic experts and promote themselves as economics experts to the common people.
Pranab Mukherjee, the old, one-time economics college professor, Finance Minister followed the textbook prescription on the one hand by raising indirect taxes on these fuels and some services and followed them up on the other hand with his contra-textbook proposals to reduce income taxes in order to put into the hands of the people more disposable income so that could buy the goods and services at higher prices.
Economics is not what is written in the textbooks but what the politicians say and do!
Some clever chap in the media has worked out that a person earning Rs 8lakhs or more will get a savings of Rs 60, 000 while the higher petrol and diesel prices will mean a higher expenditure of Rs40,000 or so - the person however cleverly forget to mention that the large number of tax payers below the income level of Rs1.6 lakhs per year will receive no tax benefit, nor will those who are near or below the poverty line: presumably, he thinks that people below the poverty line will find their wage rtes increasing as the Governmenmt steps up rural development expenditure and spending under National Rural Employment Guarantee Scheme. This may in turn raise the money ncome of all those who are below the minimum taxable income, except for the low pension income retires who were not lucky enough to have worked in the Government tht pays high pensions with periodic adjustments for inflation. Good. Incomes would rise to compensate for inflation in expenditure.
The Delhi School Economics graduate communist leader was probably not so clever or quatitative enough to figure this out before giving his comment to be carried by the Press for the consumption of the poor citizens. Finance Minister however had calculated upfront the inflationary impact of his budget announcements and proposals at 0.41%. The communist leader may not have known that such simple calculations normally are done without the help of a pen, writing paper or calculator or computer.
Economics textbooks prescribe what governments are not to do to avoid inflation. If those prescriptions are not followed and inflation rate becomes high as a result, economics textbooks say that governments stop doing what they should have not done in the first place and urge citizens to tighten their belts till supply increases to match demand.
As in my childhood days, even now both educated and uneducated brains failed to figure out that governments are the basic cause of inflation in a country like ours. Foolish politicians fight their battles to ensure that demand increases more than the supply does. Inflation comes down as people have no alternative ultimately but to tighten their belts and as supplies manage to increase with a time lag: governments only take credit for inflation going down.
If citizens have to live with large government budgets, people have to live with inflation. There is no escape. Countries which had experienced long periods of low inflation are countries with citizens who could during those periods force their politicians to stay away from the profligacy of big and grwoing spending, borrowing, deficit financing and taxing operations.
Treat the irresponsible patient first instead of allowing the patient to create havoc in the hospital, if you want to live comfortably. Politicians need to be taught the lessons again and again as they are irresponsible mentally-disadvanaged patients.
It does not require economists to understand that inflation is bad for most citizens for most of the time (some times for some citizens it may be good, eg., with my salary being linked to inflation during the 1970s, I used to look forward to high inflation because my expenditure pattern was less sensitive to inflation than my income was and less sensitive to inflation compared to many others(maybe I had also sufferred from money illusion) or for example, recently sugar mill companies saw a four fold rise in their profits.
But every citizen is an inflation expert. Almost everyone has the same set of recommendations: government must fix prices of essential commodities and distribute them from fair price shops ( in our childhood days the emphasis was on raiding the traders who were also turned hoarders and on rationing), stop export of essential goods ( India of course have very little of such exports), import from abroad (this prescription is rather a recemt phenomenon after India has moved a little towards globalization: in our childhood days imports were considered as against the great virtue of self-reliance), call strikes and bandhs against the government's inability to curb inflation and so on. Unfortunately, the text books say that to curb inflation in an excess demand situation, one needs to cut demand by reducing disposable incomes in the hands of the people by raising taxes and reducing government expenditure. It is never clear to many students of economics why economics textbooks were so harsh to recommend reducing dispoable incomes by raising income taxes, reducing subsidies and increasing taxes on the production or sales of commodities. Why raise the price of commodities by levying highers taxes when the prices are already going up? Why reduce disposable income of people when they are already unable to make both ends meet. A veteran graduate of Delhi School of Economics and now a prominent communist party leader therefore has said that Finance Minister Pranab Mukherjee's Indian Union Budget announcement to increase the levy on motor spirit and diesel oil will increase inflation especially through the cascading effect. I understand that a rise in tax levies on these fuels will increase prices of commodities and services which consume these fuels for their production and transportation to reach the consumers. But leftist economists generally have difficulty in understanding economic theories developed in the Western countries, except of the Marxian variety. They are not analytically strong enough to differentiate between a one shot price rise (which is not inflation) and a sustained process of rising prices (that is what inflation is). With such economics education it is hardly surprising, no communist country has been able to solve the problem of inflation so far without making goods disappear from the government controlled shops and long queues at their ration shops. It is only more dangerous to India that such politicians claim to be economic experts and promote themselves as economics experts to the common people.
Pranab Mukherjee, the old, one-time economics college professor, Finance Minister followed the textbook prescription on the one hand by raising indirect taxes on these fuels and some services and followed them up on the other hand with his contra-textbook proposals to reduce income taxes in order to put into the hands of the people more disposable income so that could buy the goods and services at higher prices.
Economics is not what is written in the textbooks but what the politicians say and do!
Some clever chap in the media has worked out that a person earning Rs 8lakhs or more will get a savings of Rs 60, 000 while the higher petrol and diesel prices will mean a higher expenditure of Rs40,000 or so - the person however cleverly forget to mention that the large number of tax payers below the income level of Rs1.6 lakhs per year will receive no tax benefit, nor will those who are near or below the poverty line: presumably, he thinks that people below the poverty line will find their wage rtes increasing as the Governmenmt steps up rural development expenditure and spending under National Rural Employment Guarantee Scheme. This may in turn raise the money ncome of all those who are below the minimum taxable income, except for the low pension income retires who were not lucky enough to have worked in the Government tht pays high pensions with periodic adjustments for inflation. Good. Incomes would rise to compensate for inflation in expenditure.
The Delhi School Economics graduate communist leader was probably not so clever or quatitative enough to figure this out before giving his comment to be carried by the Press for the consumption of the poor citizens. Finance Minister however had calculated upfront the inflationary impact of his budget announcements and proposals at 0.41%. The communist leader may not have known that such simple calculations normally are done without the help of a pen, writing paper or calculator or computer.
Economics textbooks prescribe what governments are not to do to avoid inflation. If those prescriptions are not followed and inflation rate becomes high as a result, economics textbooks say that governments stop doing what they should have not done in the first place and urge citizens to tighten their belts till supply increases to match demand.
As in my childhood days, even now both educated and uneducated brains failed to figure out that governments are the basic cause of inflation in a country like ours. Foolish politicians fight their battles to ensure that demand increases more than the supply does. Inflation comes down as people have no alternative ultimately but to tighten their belts and as supplies manage to increase with a time lag: governments only take credit for inflation going down.
If citizens have to live with large government budgets, people have to live with inflation. There is no escape. Countries which had experienced long periods of low inflation are countries with citizens who could during those periods force their politicians to stay away from the profligacy of big and grwoing spending, borrowing, deficit financing and taxing operations.
Treat the irresponsible patient first instead of allowing the patient to create havoc in the hospital, if you want to live comfortably. Politicians need to be taught the lessons again and again as they are irresponsible mentally-disadvanaged patients.
Friday, February 26, 2010
Pranab Mukherjee Sets Example as A Policy Economist
The Union Budget presented on February 26 helps a better appreciation of the competence and skill of the Indian Finance Minister, Pranab Mukherjee. He has proved that he is indeed capable of utlising himself most effectively to the cause of the nation as the most experienced politician and minister in the country with diversified exposure. His maturity, skill and insights lead him to tread the course of the possible , to allow youthful, exuberant opposition within his party or coalition government to correct government action further time to understand the writings on the wall and to let the stale head-count, vociferous opposition to waste more of their energy in criticising him in ways that would sooner or later make them irrelevant to the common public. He puts more money in the hands of taxpayers to pay higher prices of food and higher taxes on fuel should they want to consume more fuel in preference to other iotems of consumption and chose to add 20,000 more savings.
The economy has been largely growing, not because of what Government does but inspite of what politicians and governments do. He has learnt this lesson and therefore carefully avoided doing things that could spoil the economy's tempo of growth. Rather, he has allocated more money for infrastructure, education and rural development to facilitate private sector economic activities that result in economic growth.
He knows that governments can do very little to control inflation and left it to market forces to augment supply or shift supply curve rightwards with the little help he could provide through tax sops and allocation to agriculture. So long as the growth momentum is sustained by the economy, it contributes to his fiscal consolidation objective. This is the first budget in Indian history that is consistent with an economy that really depends on and utilises market mechanism whereever it is appropriate. He has successfully unlearnt the old practice of strong-arm God-playing Government role that he had to practice when he first became a finance minister decades back. He promises to be out of Government when the tenure of the current Lok Shabha ends. Hopefully, younger politicians across parties learn the wisdom of accepting the power of the market forces with humility and restrain themselves from fighting the market forces with economic terrorism through use of unlimited State power - an addiction that almost all politicians in India enjoy from the extreme right to the extreme left. Pranab Mukherjee has set examples for the ardent advocates and activists of both economic reforms and State command economy: 'do not hurry with missionary zeal to impose the Truth you have realised by using all of the powers you derive from being a part of the State/ Government or from being a leader of the people - tolerate petulant behaviour of others and give them more and more time to recognise their foolishness'.
The economy has been largely growing, not because of what Government does but inspite of what politicians and governments do. He has learnt this lesson and therefore carefully avoided doing things that could spoil the economy's tempo of growth. Rather, he has allocated more money for infrastructure, education and rural development to facilitate private sector economic activities that result in economic growth.
He knows that governments can do very little to control inflation and left it to market forces to augment supply or shift supply curve rightwards with the little help he could provide through tax sops and allocation to agriculture. So long as the growth momentum is sustained by the economy, it contributes to his fiscal consolidation objective. This is the first budget in Indian history that is consistent with an economy that really depends on and utilises market mechanism whereever it is appropriate. He has successfully unlearnt the old practice of strong-arm God-playing Government role that he had to practice when he first became a finance minister decades back. He promises to be out of Government when the tenure of the current Lok Shabha ends. Hopefully, younger politicians across parties learn the wisdom of accepting the power of the market forces with humility and restrain themselves from fighting the market forces with economic terrorism through use of unlimited State power - an addiction that almost all politicians in India enjoy from the extreme right to the extreme left. Pranab Mukherjee has set examples for the ardent advocates and activists of both economic reforms and State command economy: 'do not hurry with missionary zeal to impose the Truth you have realised by using all of the powers you derive from being a part of the State/ Government or from being a leader of the people - tolerate petulant behaviour of others and give them more and more time to recognise their foolishness'.
Saturday, February 20, 2010
Wonderland Economy03: InternationalTrade
What did the Wonderland citizens do in the fourth year? An interesting event took place in the beginning of the year. One morning, Econ and Wonder while taking bath in the sea noticed a boat sailing at a distance and were thrilled. They waved their colored clothes to attract the attention of the people in the boat, hoping that they would rescue Econ family to their mainland home. Fortunately, the people in the boat noticed Econ and Wonder and turned their boat towards their island. Unfortunately, a man and a women came down from the boat after anchoring it near the beach and it turned out that this couple was in the same situation as Econ family: they had also lost themselves in the sea storm and currently living in another uninhabitated land a few nughtical miles away. Both families were please to meet each other and had lunch together. The visitors mentioned that they had named their island as Greatland and they were living on daily diet of only roasted chicken as there were planty of such birds available in that land. Since they had no fruit-bearing trees in Greatland, they could not eat fruits.
They showed interest in exchangung some chicken for fruits of wonderland. Both the families entered in to an agreement to trade. W-land would supply fruits to G-land and G-land would supply chicken every month. G-land would use their boats to bring chicken and ferry back fruits. The G-land citizens calculated that they could in a year have 2000 surplus chickens that could supply to W-land. However W-land citizens calculated and said that they could not consumed more than 1000 chickens a year. The G-land said they would like to have 3000 fruits from W-land. But Econ did some calculations and said they could offer only 2000 fruits a tear. The G-land couple pointed out that since they only have a boat, the chicket and fruits can only be transported by them and in the process they would lose their productive time. Econ then proposed that they would give 400 fruits to G-land for the boat transport service (12 times a year of boat trnsport for moving chicken and fruit). They then entered in to a trade agreement valid for one year.
At the end of the year, Econ recoded the accounts of the economy for the year. Since they gathered 6500 fruits during the year, GDP=X=6500. The couple and their child consumed 4500 fruits, besides 1000 imported chickens equavent to 2000 Fruits. They also purchased 400 fruits worth of imported transportation services from G-land. So, their consumption was C=4500+2000+400 =6,900. Ekon was surprised as to how they could Consume more than their income Y? He checked the fruit stocks. The stocks had declined from 2500 to 2100. Thus, change in capital stock over the year amounted to dK= -400. This meant I= -400. This meant they had negative Saving (drawing down of past accumulated savings. So, S=-400. He also noted that there were two new items to be accounted for: Exports (X) and Imports (I)Now he checked that total income and expenditure matched. 6500= Y= C+I+X-M=6900- 400 + 2400 -2500=6500. He also noted that exports and imports exactly matched.
Now, he thought about growth. In the previous year there was a growth in GDP because their productivity of fruit collection increase due to capital investment on storage and ladder and plucking sticks. But this year their saving and Investment became negative. So, how could the GDP increase? The GDP increased because this year their labor effort increased as both the husband and wife could work for more time as they were not sick or pregnant. So he concluded that Y increases if Investments increased and productivity increased or labor effort increased. But trade increase their Y? He noted while Y increased due to exports, there was an equivalent decline in Y due to imports.
What if X was greater than M? (X-M) would be positive and hence would have increased Y. But if domestic output did not increase, Y could not have increased nor would X increase.
He started wondering about how to increae Y further. Wonder came up with an idea. She said that she could reduce some chicken consumption and use part of the imported live chicks to raise more chicks from their eggs. The next year they did just that. What happened next?
They showed interest in exchangung some chicken for fruits of wonderland. Both the families entered in to an agreement to trade. W-land would supply fruits to G-land and G-land would supply chicken every month. G-land would use their boats to bring chicken and ferry back fruits. The G-land citizens calculated that they could in a year have 2000 surplus chickens that could supply to W-land. However W-land citizens calculated and said that they could not consumed more than 1000 chickens a year. The G-land said they would like to have 3000 fruits from W-land. But Econ did some calculations and said they could offer only 2000 fruits a tear. The G-land couple pointed out that since they only have a boat, the chicket and fruits can only be transported by them and in the process they would lose their productive time. Econ then proposed that they would give 400 fruits to G-land for the boat transport service (12 times a year of boat trnsport for moving chicken and fruit). They then entered in to a trade agreement valid for one year.
At the end of the year, Econ recoded the accounts of the economy for the year. Since they gathered 6500 fruits during the year, GDP=X=6500. The couple and their child consumed 4500 fruits, besides 1000 imported chickens equavent to 2000 Fruits. They also purchased 400 fruits worth of imported transportation services from G-land. So, their consumption was C=4500+2000+400 =6,900. Ekon was surprised as to how they could Consume more than their income Y? He checked the fruit stocks. The stocks had declined from 2500 to 2100. Thus, change in capital stock over the year amounted to dK= -400. This meant I= -400. This meant they had negative Saving (drawing down of past accumulated savings. So, S=-400. He also noted that there were two new items to be accounted for: Exports (X) and Imports (I)Now he checked that total income and expenditure matched. 6500= Y= C+I+X-M=6900- 400 + 2400 -2500=6500. He also noted that exports and imports exactly matched.
Now, he thought about growth. In the previous year there was a growth in GDP because their productivity of fruit collection increase due to capital investment on storage and ladder and plucking sticks. But this year their saving and Investment became negative. So, how could the GDP increase? The GDP increased because this year their labor effort increased as both the husband and wife could work for more time as they were not sick or pregnant. So he concluded that Y increases if Investments increased and productivity increased or labor effort increased. But trade increase their Y? He noted while Y increased due to exports, there was an equivalent decline in Y due to imports.
What if X was greater than M? (X-M) would be positive and hence would have increased Y. But if domestic output did not increase, Y could not have increased nor would X increase.
He started wondering about how to increae Y further. Wonder came up with an idea. She said that she could reduce some chicken consumption and use part of the imported live chicks to raise more chicks from their eggs. The next year they did just that. What happened next?
Thursday, February 18, 2010
Wonderland Economy 02: Growth
In the third year, Econ and Wonder did not spend time collecting fruit for the first 45 days. They survived by eating the Fruits in the stock and put their hard labor in building a thatched hut with three rooms: one for storing fruits and the other two for their living and working. They also made two thin but stout long wooden sticks and two ladders made from branches of trees that would enable them to collect more fruits. The stock of apples therefore got converted into physical assets: house, working place and a storage. All these are durable assets for productive use or consumption over longer periods than one year.
Since both worked together with equal effort, they received income of F250 each during this period. Their past savings first got converted into stocks of friuts for future use and then into some physical capital assets.
With the production of capital assests, their productivity and production increased. Together they collected during the third year 6,000 fruits. Since Wonder had to deliver and look after a baby, her contribution was 2500 and Econ's F3,500. But they had also produced physical capital assets worth F500. So, what was Nation Income or GDP? Y= F6,500. What was the income distribution? Ekon earned F3750 and Wonder F2750. What did the citizens do with the income. They consumed 4,000 fruits. So, C=F4000. Therefore Savings S= F2500. They invested all their savings into investments by just increasing the capital stock from F500 to F3000 (Physical Capital of F500 and fruit stock of F2500). So Investment in the third year was F2,500. This is exactly equal to the increase in capital stock from F500 to F3000. They checked their calculations and Found that GDP=Y=C+S= C+I, I=dK and S=I. In the third year, third citizen was born: the baby was named Wondeful Economist the First or WE1 for short.
How did the economy grew? Y in the first year was F4000, in the second year F3000 and in the third year F6500. So, the economy grew by a negative 25% in the second year (i.e., declined or shrinked by a fourth from the first year's level) and increased by 116.7 % in the third year. With capital stock, productivity and production increased considerably.
Since both worked together with equal effort, they received income of F250 each during this period. Their past savings first got converted into stocks of friuts for future use and then into some physical capital assets.
With the production of capital assests, their productivity and production increased. Together they collected during the third year 6,000 fruits. Since Wonder had to deliver and look after a baby, her contribution was 2500 and Econ's F3,500. But they had also produced physical capital assets worth F500. So, what was Nation Income or GDP? Y= F6,500. What was the income distribution? Ekon earned F3750 and Wonder F2750. What did the citizens do with the income. They consumed 4,000 fruits. So, C=F4000. Therefore Savings S= F2500. They invested all their savings into investments by just increasing the capital stock from F500 to F3000 (Physical Capital of F500 and fruit stock of F2500). So Investment in the third year was F2,500. This is exactly equal to the increase in capital stock from F500 to F3000. They checked their calculations and Found that GDP=Y=C+S= C+I, I=dK and S=I. In the third year, third citizen was born: the baby was named Wondeful Economist the First or WE1 for short.
How did the economy grew? Y in the first year was F4000, in the second year F3000 and in the third year F6500. So, the economy grew by a negative 25% in the second year (i.e., declined or shrinked by a fourth from the first year's level) and increased by 116.7 % in the third year. With capital stock, productivity and production increased considerably.
Wonderland Economy 01: Income & Expenditure
Econ married Wonder and set of on sail for Honeymoon in the sea in their small boat. They wre unfortunate and faced a storm. The boat capsized anf after hours of swimming they found themselves in an unhabitated island. Since there was no way of going back home, they decided to settle down in the island that Econ named Wonderland after his beloved wife. There was nothing to eat on this island except fruits. They lived on fruits. Both of them plucked fruits. In the first year they plucked in all 4000 fruits. Econ told his wife that the Wonderland's economy had a National Income of F4000 where F stood for Wonderland Unit of money. They of course needed no currency nor money because there was no exchange to be made among the citizens of Wonderland yet. But Econ calculated that he himself gathered 2000 fruits, Wonder 1500 and the remain 500 fruits cam through joint efforts. So, Wonder said that his income was F2250 and Wonder's F1750. During the year they consumed all the fruits they had gathered. So, their National expenditure worked out to F4000.
In the second year, Econ fell sick in the initial three months and Wonder became pregnant and unable to work much in the last quarter of the year. Their fruit collection (effective production) during the year was: Econ 1300 and Wonder 1300 and jountly 400.Thus Gross Domestic Product or GDP was F3000 (Fruits that were not collected, eaten or stored but remained on the trees were not really effective production and therefore not counted}.The output produced had to be distributed in some manner as income: distribution was Econ F1500 and Wonder F1500. Thus, they reckoned the National Income as Y=F3000. More fair distribution of income came about this year due to sickness and pregnancy. This year however, they consumed only 2500 fruits because of sickness or loss of appetitie due to sickness, pregnancy and their decision to save for the rainny day. So, Natiional Saving was S=F500 and National Consumption Expenditure was C=F2,500. Since Wonder ate 1200 fruits, her consumption expenditure was F1200 and Econ's F1300. Naturally Econ saved less: his saving was F200 and Wonder's saving F300. Wonder became wealthier than Econ. But the entire National Income had to be spent. Consumption expenditure was C=2500. The rest was saved meaning not consumed. They called this as Investment (I) expenditure which resulted in an inventory or stock or capital for use later. Earlier there was no capital stock. But because of Saving and Investment expenditure, there is an increase in Capital from K=0 to K=F500. Thus Investment was nothing but increase in Capital ssstock. They wrote in symbol: dK=I, where d denoted change and hence dK was change in capital stock.
What happened in the next year? They used this capital stock to productive use by building up an asset. We also note thatonly hard labor effort by the husband and wife resulted in GDP or National Income as also consumption, Saving and Capital formation or Investment. Everything happened because of labor effort of the two citizens of the country. Income was distributed as per the contribution or productivity of the two citizens of Wonderland. Capitalism, Socialism or Communism have not come to confuse the citizens. Nor has Government come to tax away the income of the citizens. This would continue for some time. Things wou;d get progressively complicated and cause philosophers to get confused and pick up the business of confusing other people.
We come to the thirrd year later. Just now we note that GDP = National Income=Y=C+S=C+I=Nationa Expenditure.
In the second year, Econ fell sick in the initial three months and Wonder became pregnant and unable to work much in the last quarter of the year. Their fruit collection (effective production) during the year was: Econ 1300 and Wonder 1300 and jountly 400.Thus Gross Domestic Product or GDP was F3000 (Fruits that were not collected, eaten or stored but remained on the trees were not really effective production and therefore not counted}.The output produced had to be distributed in some manner as income: distribution was Econ F1500 and Wonder F1500. Thus, they reckoned the National Income as Y=F3000. More fair distribution of income came about this year due to sickness and pregnancy. This year however, they consumed only 2500 fruits because of sickness or loss of appetitie due to sickness, pregnancy and their decision to save for the rainny day. So, Natiional Saving was S=F500 and National Consumption Expenditure was C=F2,500. Since Wonder ate 1200 fruits, her consumption expenditure was F1200 and Econ's F1300. Naturally Econ saved less: his saving was F200 and Wonder's saving F300. Wonder became wealthier than Econ. But the entire National Income had to be spent. Consumption expenditure was C=2500. The rest was saved meaning not consumed. They called this as Investment (I) expenditure which resulted in an inventory or stock or capital for use later. Earlier there was no capital stock. But because of Saving and Investment expenditure, there is an increase in Capital from K=0 to K=F500. Thus Investment was nothing but increase in Capital ssstock. They wrote in symbol: dK=I, where d denoted change and hence dK was change in capital stock.
What happened in the next year? They used this capital stock to productive use by building up an asset. We also note thatonly hard labor effort by the husband and wife resulted in GDP or National Income as also consumption, Saving and Capital formation or Investment. Everything happened because of labor effort of the two citizens of the country. Income was distributed as per the contribution or productivity of the two citizens of Wonderland. Capitalism, Socialism or Communism have not come to confuse the citizens. Nor has Government come to tax away the income of the citizens. This would continue for some time. Things wou;d get progressively complicated and cause philosophers to get confused and pick up the business of confusing other people.
We come to the thirrd year later. Just now we note that GDP = National Income=Y=C+S=C+I=Nationa Expenditure.
Friday, January 1, 2010
Economics Aids Politicians' Fortune
Economics has once again come to contribute to the sustainability of political regimes' merriment. Adam Smith largely argued for the efficiency of 'invisible hand' that constrained the profligate spending hands of the political regimes. So, Marx helped plant the seeds of political regimes that would merrily spend poor people's hard earned money. But the liberals and democrats had difficulty in adopting that model, leaving Marx to be picked up by the politicians in Russia first and variants of their model proliferate in poor State-dictated economies in Asia as the colonial rulers evacuated in the twentieth century. But the western capitalist economies of richer nations still had mental blocks to accept the principle of explicit politician-ruled economic systems. At the beginning of the Great Depression of the 1930s Roosevelt found it difficult to adopt Keynes' suggestion for and defense of large State-spending (even for digging holes in the earth and filling them up) to get out of the economic mess. The politicians in capitalist Europe and the United States searched for alternative models of enjoying unlimited spending power. Samuelson's synthesis models helped create an avenue for steady growth of public expenditure supervised by politicians and provided Government's Budget a central place in the economic system. This together with the opportunity to commercialize military technology and equipment and extend tied foreign aid to the war-ravaged and the third world countries helped political regimes in capitalist economies to expand their legitimate empire of spending profligacy. Capitalist economy governments soon became the overwhelmingly dominant consumer or supplier in many markets both in the real and the financial sectors.
Friedman's logic of keeping governments out from most markets and economic activities did become popular among the people at large but failed to affect the popular addiction to complete faith and dependence on money gobbling political governments: irrespective of what the ultimate outcome would be, Governments, like mothers, were expected to do anything that was required to ensure that the children of God get continuously improving supply of employment, income, goods and services. This concept of economic freedom, rather freedom from economic worries pervaded the developed, capitalist economy democracies as much as it enchants the developing and the communist world. Since no political animal succeded in finding as yet the magic wand of ensuring sustained freedom from economic worries, people would continue to struggle under economic hardships and uncertainty in the hope of the success of the Savior - the political lords of the State.
Keynes- Samuelson Rescue
The Great Recession that began in 2008 seems to be getting over, although pessimists still expect a 'double-dip recession' to witness its second dip soon, raising hopes in the minds of the Marxist faith sadly disappointed over seemingly yet another surprise capitalist recovery from the brinks of a great collapse to extinction. But the political regimes are enjoying the great surge in their spending power. First, the US ran through great budget/ fiscal deficits since the beginning of the new century and encouraging and prodding the financial sector to fall into the trap of childish imprudence to support the political dream of home-ownership to all - irrespective of the varying economics of individual investment in house-ownership, by encouraging unsustainable leveraging. The artificial housing mortgage boom sucked in resources from everywhere creating employment and income as well as larger tax revenues (that could be wasted in profligate political spending. The inevitable burst of the boom caused a great financial sector crisis around the World, accentuating the normal recessionary phase of capitalistic trade cycle into the likes of the frightening Great Depression of the 1930s.
Fed Chairman Ben Shalom Bernanke with his in depth of study of the Great Depression led the US politicians to accept the so-called bail-outs and stimulus packages: with great drama over the compensation of greedy and self-paid financial sector bosses, the politicians sitting in opposite beaches took away huge sums of public money for exercising their spending freedom. This was copied by all Governments throughout the World from Europe to Asia including the right-handed globalizing left-handed communist China. For the third country politicians including India this was a great opportunity of using profligate spending power: the businessmen were happy with lower interest rates, easy liquidity (now called, quantitative easing) and bursting government spending to support consumer demand, while the common people thanked government action to save employment (even as unemployment percentage doubled in less than 12 months in the US). The Keynesian economists were happy that the entire world was at last now listening to Keynes advice made eight decades ago and Samuelson could see his multiplier-accelerator model at work world-wide before he passed away.
Awaiting Acceleration in Revival
But when will the accelerator part of the model become strong enough to allow governments to rewind stimulus and the economy will still be growing after absorbing the negative multiplier effect of lowering or withdrawal of stimulus? No one is certain yet. So, politicians can continue with their profligacy: spend to invite problem, spend more to attack problem and spend till the current problem gets solved and in the process a new problem emerges, and spend all the more again when the new inflation problem replaces the old recession problem. Government expenditure must continuously grow to satisfy the politicians appetite to spend. Every time, economics will come to justify larger spending power to political regimes. So, the US stimulus package in 2010 will be larger than that in 2009. India would be spending more. US inflation rate is still low, but India is facing a sharp rise in inflation.
Spend to curb future Inflation
When will the inflation problem emerge? US inflation rate is still low, but India is facing a sharp rise in inflation. The economists have an answer to deal with inflation as well. Reduce budget deficit, liberalize imports and expand capacity to match demand growth. The economists of the left handed variety are already worried about huge budget/ fiscal deficit in the US, other developed countries and countries like India (no one has clear idea of how budget deficit may be estimated somewhat correctly for China)and the consequential resurgence of inflation the apprehend. They will continue to raise progressively louder alarms if the governments do not rein in budget deficits and protect the weak and the middle classes from the deleterious impact of rising prices. So, Governments will, sooner or later, raise taxes on the rich and continue to spend vigorously to protect the non-rich notwithstanding the right-handed economists' opposition of profligate wasteful public expenditure (governments round the world have developed an unassailable reputation of using of pubic money in the most inefficient manner). The businessmen will reluctantly absorb the taxes waiting for prices to rise further to retain commercially viability and attractiveness of their enterprises.
When will inflation rise and taxes be raised? Some Keynesian economics would not call for raising taxes till capacity seems to be on the verge of falling short of demand. So this measure could wait for a while in most countries before optimism about economic expansion returns. Meanwhile, if food prices continue to rise following world-wide crop-shortfalls and food shortages, what will the politicians do? Politicians know the art of managing the citizens' outburst by diverting attention to some other problems - there are many of these available: global warming, terrorism, religious and other social conflicts: one government may be replaced by another government to satisfy citizens if they so desired.
US Recovery Signs Spread Optimism!
The United States seems to be on the path of recovering from the bottom. With greater stimulus spend in 2010, unemployment may not reach 11 % and soon start falling, even if at a very slow rate over the next Nina / ten months. Thanks Giving and Christmas sales are estimated to have been better in 2009 than in 2008. Households had deferred purchases following the rapid growth of unemployment following the fall of the Lehman Brothers and saved more of their incomes preparing for anticipated job loss. Those who could retain their jobs (90% did) have started releasing their pent-up demand for goods. Private sector investment may take some more time to pick up and unutilised capacity still remains high even if the inventories have gone down.
So, let us assume that the Great Recession has bottomed out in the US and with little or more time lag the Great Recession will soon be a past throghout the World. Inflation will be managed as it develops with the recovery gathering momentum and the different economies entering the expansion phase in another 13 to 20 months. Yet, the World economy will still be back to square one: the major international economic imbalance that excerbated the normal capitalistic recession into a Great Recession through the medium of a severe financial sector meltdown, still remains.
Back to Square One: Unsustainable Trade Balances
The adverse impact of the financial meltdown has been attended to successfully: maybe the politicians will, for a while, dare lure financial institution chief executives in to imprudent behavior as they did in the US during 2002- 2005, prodding the mortgage refinanciers, commercial banks, investment banks, insurance companies and the regulators with a implicit State comfort that nothing could get wrong so that these institutions suck in domestic and foreign debt money without adequate equity back-up. This may not be repeated. But so long as the basic economic imbalance in international trade continues, this will create pressure to generate new avenues to seed the next financial disaster. The sustained favourable trade surplus of a poor country like China selling goods cheaper to the Western capitalist economies to keep employment in China high through low\ low wage rates relative to productivity and administered, under-valued exchange rate of Chinese yuan, will germinate seeds of next disaster. So will the continuation of huge current and trade account deficit to keep inflation low even as unskilled labor there becomes worse off as Samuelson's theorem had predicted.
Yes, China may suddenly find interest in incraesing gold production and gold holdings rather tha investing mostly in US treasury bills or the Euro, and cause gold prices to continuosly rise sharply as they have been in the recent past.as other emerging countries try buing into gold. Yes, this may benefit the US as well since it has the largest stock of gold reserves whose value would be rising. But, just as the US home prices could not rise indefinitely and had to cause a finacial crash, the movement of gold prices will have its own effect in the currency and precoius metal markets with speculators searching for opportunity to book profits at some time or the other. As China's foreign investments rush in to mining properties and agricutural lands in African, Latin American and other poorer third world countries, the currency markets will be impacted. Currency markets are ultimately an integral part of the financial markets. There is always the apprehension that the huge stimulus spending of the Chinese political regime, using their banks may have considerably hurt their financial health to make it riskier to transact business with them
Economics Aid for the Future
Economists do not as yet seem to have a reasonably acceptable model to capture all this ramifications of imbalance in international trading accounts of nations and recommend to politicians policies that are as convincing as those of the Keynes and those that are derived from Samuelson's multiplier-accelerator models. Will economists find something soon? They have the Hecksher-Ohlin Model framework and the related analyses on international trade. How would thse be developed further and extended to be relevant and useful to the politicians across the World to initiate co-ordinated action without much bickering as they did to avoid protectionism, following Adam Smith and embark on huge stimulus packages, following Keynes in 2009? Maybe extensions of Hecksher-Ohlin models will not be easily accepted by the third world country politicians. Maybe economists will need also to model, for politicians to understand, the inter-realtions of the international markets for precious metals, rapidly-dwindling other industrial metals, currency and currency derivatives, financial markets and the newer markets for trade in the existing and emerging technologies of containing global warming and carbon emmisions as well as water conservation, and solid waste recycling.
Maybe China, India and other fast developing emerging economies will agree to find ways to sustain growth while reducing their claims on exhastible natuural resources and polluting the global climate in favour of the poorest nations in Africa and parts of Asia. All these may need to be incorporated in open economy economic growth models that economists would be developing now. Economics has to extend aid to political regimes to spend public money inefficiently and wastefully, and yet keep the citizens continually addicted to their faith on politicians as the Saviors once again when the next Great Recession occurs out of the still persisting international trade imbalace. Maybe some economists are just about completing their inquiry into the political policy requirements for the Stability of Growing Wealth of Golbalised Nations.
Friedman's logic of keeping governments out from most markets and economic activities did become popular among the people at large but failed to affect the popular addiction to complete faith and dependence on money gobbling political governments: irrespective of what the ultimate outcome would be, Governments, like mothers, were expected to do anything that was required to ensure that the children of God get continuously improving supply of employment, income, goods and services. This concept of economic freedom, rather freedom from economic worries pervaded the developed, capitalist economy democracies as much as it enchants the developing and the communist world. Since no political animal succeded in finding as yet the magic wand of ensuring sustained freedom from economic worries, people would continue to struggle under economic hardships and uncertainty in the hope of the success of the Savior - the political lords of the State.
Keynes- Samuelson Rescue
The Great Recession that began in 2008 seems to be getting over, although pessimists still expect a 'double-dip recession' to witness its second dip soon, raising hopes in the minds of the Marxist faith sadly disappointed over seemingly yet another surprise capitalist recovery from the brinks of a great collapse to extinction. But the political regimes are enjoying the great surge in their spending power. First, the US ran through great budget/ fiscal deficits since the beginning of the new century and encouraging and prodding the financial sector to fall into the trap of childish imprudence to support the political dream of home-ownership to all - irrespective of the varying economics of individual investment in house-ownership, by encouraging unsustainable leveraging. The artificial housing mortgage boom sucked in resources from everywhere creating employment and income as well as larger tax revenues (that could be wasted in profligate political spending. The inevitable burst of the boom caused a great financial sector crisis around the World, accentuating the normal recessionary phase of capitalistic trade cycle into the likes of the frightening Great Depression of the 1930s.
Fed Chairman Ben Shalom Bernanke with his in depth of study of the Great Depression led the US politicians to accept the so-called bail-outs and stimulus packages: with great drama over the compensation of greedy and self-paid financial sector bosses, the politicians sitting in opposite beaches took away huge sums of public money for exercising their spending freedom. This was copied by all Governments throughout the World from Europe to Asia including the right-handed globalizing left-handed communist China. For the third country politicians including India this was a great opportunity of using profligate spending power: the businessmen were happy with lower interest rates, easy liquidity (now called, quantitative easing) and bursting government spending to support consumer demand, while the common people thanked government action to save employment (even as unemployment percentage doubled in less than 12 months in the US). The Keynesian economists were happy that the entire world was at last now listening to Keynes advice made eight decades ago and Samuelson could see his multiplier-accelerator model at work world-wide before he passed away.
Awaiting Acceleration in Revival
But when will the accelerator part of the model become strong enough to allow governments to rewind stimulus and the economy will still be growing after absorbing the negative multiplier effect of lowering or withdrawal of stimulus? No one is certain yet. So, politicians can continue with their profligacy: spend to invite problem, spend more to attack problem and spend till the current problem gets solved and in the process a new problem emerges, and spend all the more again when the new inflation problem replaces the old recession problem. Government expenditure must continuously grow to satisfy the politicians appetite to spend. Every time, economics will come to justify larger spending power to political regimes. So, the US stimulus package in 2010 will be larger than that in 2009. India would be spending more. US inflation rate is still low, but India is facing a sharp rise in inflation.
Spend to curb future Inflation
When will the inflation problem emerge? US inflation rate is still low, but India is facing a sharp rise in inflation. The economists have an answer to deal with inflation as well. Reduce budget deficit, liberalize imports and expand capacity to match demand growth. The economists of the left handed variety are already worried about huge budget/ fiscal deficit in the US, other developed countries and countries like India (no one has clear idea of how budget deficit may be estimated somewhat correctly for China)and the consequential resurgence of inflation the apprehend. They will continue to raise progressively louder alarms if the governments do not rein in budget deficits and protect the weak and the middle classes from the deleterious impact of rising prices. So, Governments will, sooner or later, raise taxes on the rich and continue to spend vigorously to protect the non-rich notwithstanding the right-handed economists' opposition of profligate wasteful public expenditure (governments round the world have developed an unassailable reputation of using of pubic money in the most inefficient manner). The businessmen will reluctantly absorb the taxes waiting for prices to rise further to retain commercially viability and attractiveness of their enterprises.
When will inflation rise and taxes be raised? Some Keynesian economics would not call for raising taxes till capacity seems to be on the verge of falling short of demand. So this measure could wait for a while in most countries before optimism about economic expansion returns. Meanwhile, if food prices continue to rise following world-wide crop-shortfalls and food shortages, what will the politicians do? Politicians know the art of managing the citizens' outburst by diverting attention to some other problems - there are many of these available: global warming, terrorism, religious and other social conflicts: one government may be replaced by another government to satisfy citizens if they so desired.
US Recovery Signs Spread Optimism!
The United States seems to be on the path of recovering from the bottom. With greater stimulus spend in 2010, unemployment may not reach 11 % and soon start falling, even if at a very slow rate over the next Nina / ten months. Thanks Giving and Christmas sales are estimated to have been better in 2009 than in 2008. Households had deferred purchases following the rapid growth of unemployment following the fall of the Lehman Brothers and saved more of their incomes preparing for anticipated job loss. Those who could retain their jobs (90% did) have started releasing their pent-up demand for goods. Private sector investment may take some more time to pick up and unutilised capacity still remains high even if the inventories have gone down.
So, let us assume that the Great Recession has bottomed out in the US and with little or more time lag the Great Recession will soon be a past throghout the World. Inflation will be managed as it develops with the recovery gathering momentum and the different economies entering the expansion phase in another 13 to 20 months. Yet, the World economy will still be back to square one: the major international economic imbalance that excerbated the normal capitalistic recession into a Great Recession through the medium of a severe financial sector meltdown, still remains.
Back to Square One: Unsustainable Trade Balances
The adverse impact of the financial meltdown has been attended to successfully: maybe the politicians will, for a while, dare lure financial institution chief executives in to imprudent behavior as they did in the US during 2002- 2005, prodding the mortgage refinanciers, commercial banks, investment banks, insurance companies and the regulators with a implicit State comfort that nothing could get wrong so that these institutions suck in domestic and foreign debt money without adequate equity back-up. This may not be repeated. But so long as the basic economic imbalance in international trade continues, this will create pressure to generate new avenues to seed the next financial disaster. The sustained favourable trade surplus of a poor country like China selling goods cheaper to the Western capitalist economies to keep employment in China high through low\ low wage rates relative to productivity and administered, under-valued exchange rate of Chinese yuan, will germinate seeds of next disaster. So will the continuation of huge current and trade account deficit to keep inflation low even as unskilled labor there becomes worse off as Samuelson's theorem had predicted.
Yes, China may suddenly find interest in incraesing gold production and gold holdings rather tha investing mostly in US treasury bills or the Euro, and cause gold prices to continuosly rise sharply as they have been in the recent past.as other emerging countries try buing into gold. Yes, this may benefit the US as well since it has the largest stock of gold reserves whose value would be rising. But, just as the US home prices could not rise indefinitely and had to cause a finacial crash, the movement of gold prices will have its own effect in the currency and precoius metal markets with speculators searching for opportunity to book profits at some time or the other. As China's foreign investments rush in to mining properties and agricutural lands in African, Latin American and other poorer third world countries, the currency markets will be impacted. Currency markets are ultimately an integral part of the financial markets. There is always the apprehension that the huge stimulus spending of the Chinese political regime, using their banks may have considerably hurt their financial health to make it riskier to transact business with them
Economics Aid for the Future
Economists do not as yet seem to have a reasonably acceptable model to capture all this ramifications of imbalance in international trading accounts of nations and recommend to politicians policies that are as convincing as those of the Keynes and those that are derived from Samuelson's multiplier-accelerator models. Will economists find something soon? They have the Hecksher-Ohlin Model framework and the related analyses on international trade. How would thse be developed further and extended to be relevant and useful to the politicians across the World to initiate co-ordinated action without much bickering as they did to avoid protectionism, following Adam Smith and embark on huge stimulus packages, following Keynes in 2009? Maybe extensions of Hecksher-Ohlin models will not be easily accepted by the third world country politicians. Maybe economists will need also to model, for politicians to understand, the inter-realtions of the international markets for precious metals, rapidly-dwindling other industrial metals, currency and currency derivatives, financial markets and the newer markets for trade in the existing and emerging technologies of containing global warming and carbon emmisions as well as water conservation, and solid waste recycling.
Maybe China, India and other fast developing emerging economies will agree to find ways to sustain growth while reducing their claims on exhastible natuural resources and polluting the global climate in favour of the poorest nations in Africa and parts of Asia. All these may need to be incorporated in open economy economic growth models that economists would be developing now. Economics has to extend aid to political regimes to spend public money inefficiently and wastefully, and yet keep the citizens continually addicted to their faith on politicians as the Saviors once again when the next Great Recession occurs out of the still persisting international trade imbalace. Maybe some economists are just about completing their inquiry into the political policy requirements for the Stability of Growing Wealth of Golbalised Nations.
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